Debt Debacle: Understanding Ukraine’s Default on Russian Bonds

Jason S. Levin, Vol. 37 Associate Editor

The New Year welcomed heightened political tension as legal woes between Ukraine and Russia intensified, two countries with an already tumultuous history.[1] On January 1, Russia responded to Ukraine’s December 31 default on the first tranche of debt, a $3 billion Eurobond, by initiating “procedures [for] . . . legal action.”[2] The action was filed in the London Court of International Arbitration (“LCIA”).[3] The Ukraine-Russia debt deal, struck in December 2013, provided that Russia would “[purchase] $15 billion worth of Ukrainian Eurobonds.”[4] Ukraine’s Russian debt obligation is part of a larger restructuring effort, as Ukraine recently yielded to “private credito[r]” demands, deciding not to pay back Russia in full.[5] The International Monetary Fund (“IMF”) has classified Ukraine’s debt as sovereign (as opposed to private or commercial),[6] rendering them unable to restructure in opposition to the pool of private creditors.[7] Ukraine has been working to comply with the conditions of a $17.5 billion IMF bailout.[8] Although Russia is one of the 188 IMF members,[9] the country refused to take part in the private creditor negotiations.[10] Thus, further embroiled in this controversy is the IMF’s role. In an effort to provide ongoing capital to Ukraine, the IMF recently changed its “strict policy prohibiting . . . lending ‘to countries that are not making a good-faith effort to eliminate their arrears with creditors.’”[11] Russia has since indicated on several news sources that the IMF’s changed lending policy subverts and seemingly provides approval for Ukraine’s actions.[12] Russian Finance Minister, Anton Siluanov, stated “[Russia is] concerned that changing [the IMF’s] policy in the context of Ukraine’s politically charged restructuring may raise questions as to the impartiality of an institution that plays a critical role in addressing international financial stability.”[13] This is not a new phenomenon, as myriad scholars have commented on the complexities of IMF impartiality.[14] In terms of extremes, one possible outcome is what Anna Gelpern, Professor of Law at Georgetown University, discussed in August 2014. Gelpern noted, “A single measure [could] free up $3 billion for Ukraine and send a powerful message to Russia: [The LCIA  could] refuse to enforce English-law contracts for the money Russia lent former Ukrainian president[,] Viktor Yanukovych[,] in a failed attempt to keep him in power . . .”[15] Given the possible political ramifications, it is unlikely the LCIA would be quick to reach such an outcome. Another possibility is the matter could be settled out of court. Russia’s statement regarding Ukraine’s default “left an opening” for such a settlement, as Russia portrayed a willingness to work with Ukrainian officials.[16] However, “[Russia] also believes . . . court proceedings do not preclude a constructive dialogue in order to reach an acceptable settlement of the debt.”[17] A resolution ex ante arbitration is less likely to become a reality because of the United States’ failure, in November 2015, to provide surety for Ukraine’s debt.[18] If the United States had agreed, Ukraine would have been able to restructure the debt, paying Russia equal installments over the next three years (i.e., 2016 through 2018).[19] Enforcement measures aside (as enforcing international judgments is often problematic, however, less so for arbitral awards),[20] it appears the bloodshed and political upheaval is not likely to dissipate. Yet, despite Russia’s political power and prominent role in various intergovernmental organizations, Ukraine remains optimistic and “ready to defend itself against any claim that may be brought against it, and is confident in all the circumstances of doing so successfully.”[21]

  [1] See Ukraine Profile – Timeline, Brit. Broad. Corp. (Oct. 27, 2015), http://www.bbc.com/news/world-europe-18010123. [2] Natasha Doff, Ukraine Read for Court Fight With Russia Over $3 Billion Bond, BloombergBusiness (Jan. 4, 2016, 9:14 AM), http://www.bloomberg.com/news/articles/2016-01-04/ukraine-ready-for-court-fight-with-russia-over-3-billion-bond. [3] Ukraine Officially Defaults on $3bn Debt to Russia; Moscow to Sue Kiev in London Court, Russia Today (Jan. 1, 2016, 5:08 AM), https://www.rt.com/business/327620-russia-lawsuit-ukraine-debt. [4] IMF Recognizes Ukraine’s Contested $3bn debt to Russia as Sovereign, Russia Today (Dec. 16, 2015, 11:32 PM), https://www.rt.com/business/326167-imf-ukraine-debt-russia-sovereign. [5] Doff, supra note 2. [6] The argument for commercial or private debt is best advanced on the theory of to whom the money was given. [7] See Winning, supra note 17. Ukraine “is reluctant to pay as it claims the Eurobonds purchased by Russia were a private and not a government loan granted to [the former President in 2013; however, t]he IMF has recognized the debt to Russia as an official sovereign liability.” Russia Today, supra note 10. [8] Id. [9] IMF, List of Members (June 13, 2012), https://www.imf.org/external/np/sec/memdir/memdate.htm. [10] Doff, supra note 2. The default and subsequent action was widely speculated given Russia’s failure to participate in the creditor negotiations. Jack Farchy, Russia Initiates Legal Proceedings Against Ukraine Over $3bn Debt, Financial Times (Jan. 1, 2016, 1:02 PM), http://www.ft.com/cms/s/0/fd3680cc-b07d-11e5-b955-1a1d298b6250.html. [11] Russia Today, supra note 4 (emphasis added). “Ukraine must [still] demonstrate it is open to negotiating in good faith with Russia on a deal.” Alessandra Prentice, Ukraine ‘Confident’ of Success in Russian Debt Lawsuit, Reuters (Jan. 4, 2016, 5:44 AM), http://www.reuters.com/article/us-ukriane-crisis-idUSKBN0UI0W720160104. Given “[the] subsequent inreas[e of bond financing] recourse by countries . . . and the securitization of loan portfolios to replace [traditional] bank lending, . . . a ‘good faith’ negotiation criterion was introduced.” Benu Schneider, Sovereign Debt Restructuring: the Road Ahead in Life After Debt: The Origins and Resolutions of Debt Crisis 200-01 (Joseph E. Stiglitz and Daniel Heymann eds., 2014). Further, The old bank-country relationship, which was not necessarily a benign one kept the incentive for a settlement but functioned like cartels and prolonged the restructuring process, was . . . replaced by creditors who had no long-term relationship with the debtor country, held sovereign bonds[,] and had less of an incentive to coordinate and settle a renegotiated debt agreement and thus . . . [the] good faith criterion was softened to a good faith effort (by debtors) to reach a collaborative agreement with . . . creditors. Id. [12] Moscow Wonders if IMF is Running a Fair Game, Russia Today (Dec. 10, 2015, 10:42 AM), https://www.rt.com/business/325412-siluanov-imf-impartiality-ukraine-debt. [13] IMF Recognizes Ukraine’s Contested $3bn debt to Russia as Sovereign, Russia Today (Dec. 16, 2015, 11:32 PM), https://www.rt.com/business/326167-imf-ukraine-debt-russia-sovereign. [14] See Odette Lienau, Legitimacy and Impartiality in a Sovereign Debt Workout Mechanism (Jul. 2014) Cornell L. Faculty Publications at 20 http://scholarship.law.cornell.edu/cgi/viewcontent.cgi?article=2499&context=facpub (noting that “the IMF has emerged to play multiple roles relevant to debt workouts[;]” and, more specifically, “since the turn of the millennium and particularly within the last decade the IMF has become more politically aware and more concerned about perceptions of its own representativeness, impartiality, and legitimacy”); see also Benu Schneider, Sovereign Debt Restructuring: the Road Ahead in Life After Debt: The Origins and Resolutions of Debt Crisis 201-02 (Joseph E. Stiglitz and Daniel Heymann eds., 2014) (highlighting “the IMF is . . . required to play a unique role in assisting its members to strike a judicious balance between financing and adjustment, but it runs the risk of being less effective in this role due to the absence of a framework for timely and orderly debt restructuring”). Additionally, “current implied costs of debt restructuring provide incentives for debtors to delay a restructuring and gamble in the belief that . . . if recovery takes place it will allow them to avoid a debt treatment. . . Although the IMF is better placed than other institutions to evaluate the macro framework, the IMF has a conflict of interest in its dual roles of providing advice on a feasible primary surplus and simultaneously acting as a preferred creditor. Id. [15] Anna Gelpern, Debt Sanctions Can Help Ukraine and Fill a Gap in the International Financial System at 1 (Aug. 2014), http://www.iie.com/publications/pb/pb14-20.pdf. See also Doff, supra note 4 (noting the bond is structured under English law). Undergirding this default is the former actions of Viktor Yanukovich, who, “in late 2013 as public protests took off against his swing away from association with the European Union towards deeper ties with Russia” culminated with unrest, bloodshed, and his abdication. Alexander Winning, Russia Says U.S. Refused Guarantees for Ukraine’s Liabilities, Reuters (Dec. 5, 2015, 12:25 PM), http://www.reuters.com/article/us-ukraine-crisis-russia-usa-debt-idUSKBN0TO0EW20151205. [16] Doff, supra note 4. [17] Ukraine Officially Defaults on $3bn Debt to Russia; Moscow to Sue Kiev in London Court, Russia Today (Jan. 1, 2016, 5:08 AM), https://www.rt.com/business/327620-russia-lawsuit-ukraine-debt. [18] See Alexander Winning, Russia Says U.S. Refused Guarantees for Ukraine’s Liabilities, Reuters (Dec. 5, 2015, 12:25 PM), http://www.reuters.com/article/us-ukraine-crisis-russia-usa-debt-idUSKBN0TO0EW20151205. Russia was also willing to accept guarantees from the European Union or a key international financial organization. See Russia Today, supra note 11. [19] See Winning, supra note 17. Ultimately, Ukraine “insisted it could not offer better terms [for Russia] than those given to its other creditors. Jack Farchy, Russia Initiates Legal Proceedings Against Ukraine Over $3bn Debt, Financial Times (Jan. 1, 2016, 1:02 PM), http://www.ft.com/cms/s/0/fd3680cc-b07d-11e5-b955-1a1d298b6250.html. [20] See William W. Park and Jan Paulsson, The Binding Force of International Arbitral Awards 23 Va. J. Int’l L. 253 (1982). [21] Alessandra Prentice, Ukraine ‘Confident’ of Success in Russian Debt Lawsuit, Reuters (Jan. 4, 2016, 5:44 AM), http://www.reuters.com/article/us-ukriane-crisis-idUSKBN0UI0W720160104.